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Bank of Baroda: Cautiousness pays off - Views on News from Equitymaster

Bank of Baroda: Cautiousness pays off

Jul 30, 2007

Performance summary

Interest income grows by 35% YoY on the back of 28% YoY growth in advances.

Other income grows by 64% YoY.

Net interest margins improve to 3.2% from 3.0% in 1QFY07

Provisions fall by 44% YoY

Net profit up 103% YoY in 1QFY08

Rs (m)

1QFY07

1QFY08

Change

Interest income

19,676

26,546

34.9%

Interest Expense

11,377

16,961

49.1%

Net Interest Income

8,299

9,585

15.5%

NIM (%)

3.0%

3.2%

Other Income

2,252

3,701

64.3%

Other Expense

5,513

6,843

24.1%

Provisions and contingencies

2,534

1,414

-44.2%

Profit before tax

2,504

5,029

100.8%

Tax

871

1,721

97.6%

Profit after tax / (loss)

1,633

3,308

102.6%

Net profit margin (%)

8.3%

12.5%

No. of shares (m)

365.5

365.5

Book value per share (Rs)*

230.8

P/BV (x)

1.3

* (Book value as on 30th June 2007)

A de-risked play

Bank of Baroda is the fifth largest banking entity in the country (in terms of asset size) with 4% share of the total credit disbursals at the end of FY06. Given its geographic concentration in the northern regions, the bank was a laggard in terms of credit growth in the initial years of this decade, which resulted in a loss of market share (from 5.7% in FY02 to 4% in FY06). However, a brand and operations overhaul led to accelerated growth in the last two fiscals, thus helping it stabilise its share and position itself favourably amongst its peers. Adequate capital (CAR 14.3% in 1QFY08), high NPA coverage and hedge against interest rate risks peg the bank amongst the frontrunners in the public sector banking space.

What has driven performance in 1QFY08?

Proactive re-pricing: Having one of the largest number of offshore branches amongst Indian banks continued to help Bank of Baroda tide over the liquidity constraints and margin pressures in 1QFY08. In line with its past performance, the bank continued to outdo its peers in public sector banking space in terms of asset growth. It may be recalled that the bank’s global business exposure (deposits and advances) nearly doubled, from global advances comprising 10% of total advances in FY06 reaching levels of 20% in FY07, thus clocking a growth rate of 72% YoY. The bank has not divulged the proportion to global assets in its incremental lending this quarter, but its international operations contributed 21.3% of the bank's net profits and 19.5% of the bank’s total business at the end of June 2007.

Asset book: Agri tilt…

1QFY07

% of total

1QFY08

% of total

Change

Advances

613,796

782,590

27.5%

Agriculture

70,996

11.6%

104,790

13.4%

47.6%

Retail

102,751

16.7%

142,310

18.2%

38.5%

Corporate

440,049

71.7%

535,490

68.4%

21.7%

Deposits

998,060

1,224,620

22.7%

The hike in interest rates in the domestic markets coupled with the shortage of liquidity led to a slower advance growth in the domestic markets. However, on the back of 38.5% YoY growth in retail credit (18% of total advances) and 47.6% YoY growth in its agri portfolio, Bank of Baroda registered a 28% YoY growth in advances in 1QFY08, outperforming the sector average of 24% YoY. A higher share of CASA (39% in FY07) and access to global funds has continued to cushion the bank’s net interest margins. Also, the bank has been proactive in re-pricing its lending rates along with the hike in deposit rates.

Cashing in on ‘provisions’: Bank of Baroda's recent initiatives for improving its non-fund based income resource started yielding results in FY07. The bank’s fee income, however, comprised merely 10% of the bank’s total income in FY07 and has grown at a CAGR of 8% in the last 5 years. While we know that the bank’s fee income from overseas operations grew by 25% YoY, it has not divulged the growth in overall fee income in this quarter. It may also be recalled that the bank had entered into an MOU with IDFC in FY07 for funding the projects appraised by it. This is expected to ensure good quality lending and big-ticket loans but also fetch the bank proportionate fee income.

The bank’s proactive provisioning for its investment portfolio has yielded good results this quarter as the bank was able to write back a substantial proportion of the provisioning due to fall in the benchmark GSec yields. Although, the investment book of the bank is not a concern (76% of investments are in HTM basket), diminishing fee income will endanger the sustainability of net margins going forward, as the core banking business gets commoditised and more competitive private sector and foreign players cannibalise on its market share.

Costs to even out: The bank has sustained its cost to income ratio at 55% in 1QFY08. The bank has also clarified that it has been providing for pension related expenses on actuarial basis, thus taking care of future liabilities in its books. Further, in the next 3 to 4 years, around 4,000 employees of the bank will be retiring, thus considerably lightening its wage burden (as most of these employees are in the high salary bracket). For filling the requisite vacancies, the bank will be recruiting around 300 people each year for the next 3 to 4 years, at relatively lower salary levels as compared to the retirees. We expect this to rationalise the bank's overheads and bring down its cost to income ratio at par with that of its peers in the sector. The cost to income ratio in the overseas operations was at a relatively lower 27%.

Housing slip: While the bank has witnessed a 14% YoY reduction in the absolute value of its gross NPAs over the last 12 months (2.8% of total advances from 3.9% in 1QFY07), the same are sequentially higher than the previous quarter, suggesting incremental delinquencies in the quarter under review. At the net NPA level, the higher provisioning has brought down the same from 0.9% of advances in 1QFY07 to 0.7% in this quarter (0.6% in 4QFY07). In the international operations, gross NPAs are at 0.7% while the net NPAs are zero. While higher recoveries and an adequate coverage ratio of 78% for NPAs dilute some concerns on this front, the NPA level in homes loans (3.5% in FY07) remain a peril. At the end of FY07, 10% of the bank’s corporate credit exposure was categorised in the ‘high risk’ category in terms of ratings.

What to expect?

At the current price of Rs 293, the stock is attractively valued at 0.9 times our estimated FY10 adjusted book value. The bank has marginally outperformed our broad asset growth and margin estimations and we will need to upgrade our forward estimations if the same continues in the forthcoming quarters of this fiscal. Adequate capital, a high provisioning cover, exposure in overseas markets and reasonable consistency in net interest margins makes it a de-risked play in the PSU banking space. The interest rate risk due to excessive dependence on fund-based revenues is the only downside to the prospects of the bank. We maintain our positive recommendation on the stock from a long-term perspective.

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